It was the best of times, it was the worst of times
-Charles Dickens, A Tale of Two Cities
Every year has it’s share of positives and negatives; that’s nothing new. But 2021 seemed just, different, didn’t it? The virus put a pall over everything else going on during the year, much of it from an economic standpoint being historically good. We ended the year with the stock market, as measured by they S&P 500, being up just under 27%. While the final numbers aren’t in yet, according to the Fed Bank of Atlanta’s GDPNow estimator, GDP growth for 2021 is likely to be over 5.5% - the highest in 37 years. We finished the year with an unemployment rate of 3.9%, wage growth is close to 5% and less people are collecting unemployment insurance than at any point in decades. Of course, inflation also ran hot, hitting an estimated 7% in 2021 – also the highest in decades. The stock markets, as well as they’ve been doing, are overvalued by every measure we use (the whole markets not every individual stock of course) and it looks like we’ll be getting at least a couple interest rate hikes in 2022 that could put a damper on home refinancing and suddenly make it viable to redirect some of this money from the stock market to bonds or banks where you might be able to get at least some kind of interest rate. So, we put these competing notions in our crystal ball and what does it tell us for 2022?
Hate to break it to you, but I don’t have a crystal ball; and neither does anybody else. In sports, if you find yourself leaning too far to one side and your opponent goes the other way you get beat, so you keep a nice solid stance where you can react to whatever direction things go. There are certainly trends that appear to be continuing for at least a while and we’re making some tactical position changes to hopefully take advantage of those things, but we never overcommit to one side or the other. For example, it seems likely that inflation runs at this higher rate for at least the first half of 2022 – even if it’s at a slightly lower absolute number. It took a while for these inflation pressures to ramp up and it will take a while for them to calm down. Even if the Fed raises rates to combat inflation, it seems unlikely they will do anything before March and it takes a solid quarter or two before those actions start to have an impact – so that takes us out to the Fall of next year. This means we can be somewhat confident about inflation running above 3% for a while. At the same time, while higher interest rates ultimately lead to higher savings account, CD and bond interest payments – those things also take a while to catch up with what the Fed is doing, and sometimes are affected by things outside of the Fed’s actions. So even if the Fed raises rates three times next year – at a ¼ a point each time – that still only gets us to a 1% Fed funds rate. If the Fed is successful at lowering the inflation rate at the same time, then maybe by the end of 2022 or early 2023 the real return (the interest rate minus inflation) on bonds might turn positive again. But that still means for at least another year all those fixed income options still seem less attractive as an actual investment (as opposed to a diversification tactic) so perhaps an exodus out of the stock markets into safer, suddenly positive yielding, investments may not take place all that soon. If inflation keeps running at 3-4% in the meantime, this process could take two or three full years. For these reasons we’ve positioned our portfolios under the assumption of higher inflation and negative real interest rates for at least another full year.
We’ve also seen a big increase in volatility as 2021 came to an end. Just from Thanksgiving to year end we saw 4-5% market swings, in both directions, seemingly every couple of days. Of course, the Omicron variant was the main culprit in these moves. Like a villain in a horror movie, just when we seemed to have this thing taken care of, it suddenly rose from the ashes to come after us again. I think we’re all better prepared, and if patterns from other countries manifest in the United States, we may see Omicron burn itself out by early February, but who knows really. The sheer numbers of people suddenly testing positive and the regulations about close contacts and the like, are causing people to be out of work which is taking a toll on supplies once again. There are shortages of things just like last Winter, and like last Winter it’s sort of a crap shoot about what may or may not be available. How much this affects the overall economy is impossible to know, but it can’t have zero effect. I think as long as Omicron continues to wreak havoc, we’re going to see the stock markets reacting with continued volatility. That doesn’t mean it will end up lower or higher, but the daily movements will continue to be in a larger than normal range.
On to a much more fun topic; paying taxes. Nothing actually passed last year so there are no changes in tax rates or what's deductible for 2022. The contribution limits for 401(k)’s and other company retirement plans went up slightly – but there was no change for individual IRA’s. Every year the Standard Deduction and the level at which you hit the next tax bracket are increased by inflation – because the official inflation rate was over 6% at the end of the third quarter of 2021, those levels went up by more than normal. The Standard deductions for example, increased by $400 for individuals and $800 for married filing jointly. But otherwise, for the first time in a while, there’s no major changes to speak about, except one. Last year I mentioned that the 2020 Retirement Act that changed the required distribution age from 70½ to age 72, also directed the IRS to rework the Uniform Distribution Table that gives you the number, based on your age, that you use to figure out your distribution. This table had not been changed since 1997 and as it’s based on life expectancy it was due for an update. Those new tables are out and being used for this year’s distribution calculations. Since life expectancy has gone up, the required distribution percentage has gone down, in fact the percentage you have to take out will be less this year than it was last year across every age. The actual dollar amount you have to take is a factor of that chart and the account balance on 12/31; given how well the markets did last year it’s still likely you will have to take a higher dollar amount than in 2021. For example, at age 72 the old distribution percentage was 3.91%, and it’s now 3.55%. Likewise for age 80 it went from 5.35% to 4.96% and from 6.76% to 6.25% at age 85. In dollar amounts, that means an 80-year-old with a $500,000 IRA will be required to distribute and pay taxes on about $1,950 less in 2022. It’s not a life changing adjustment, but as my grandfather used to say, every little bit helps.
My family and I got to get away the first week of January. We found ourselves in Sunny, warm Puerto Rico where the sight of Christmas decorations on people’s houses in 85-degree weather seemed quite strange to a New England boy like me. Apparently Three Kings Day, January 6th, is a bigger holiday in Puerto Rico than Christmas itself, so the lights stay up at least until then. Seeing those Christmas displays in the warm weather reminded me a little bit of the entire year of 2021 – it was great in a lot of ways but just seemed a little bit wrong. I hope very much 2022 is the year we finally get this pandemic behind us. Let’s see what this economy can do with no restrictions, maybe these high stock prices will even be justified by strong enough earnings in a post-Covid U.S.A. But whatever happens, I’m grateful to be working with you for another year (for those of you who are on this list that are not yet clients – you’re welcome to pull the trigger whenever you wish.) As always, keep us in mind if you meet anyone who may need our services, and please let us know if we can do anything for you.
